This article is the fourth in a series addressing how to manage your company using systems and reports.
If you haven't read the 2007 Pacesetter Awards story in the July/August 2007 issue of CUSTOM HOME, dig it out and read the article about Roger Blattberg and Stacey L. Hoffman of Great Falls Construction. They won a Pacesetter Award for business management because they revamped the company's accounting system, switching to percentage-of-completion accounting. They are a great example of the point I want to make in this column: Percentage-of-completion accounting allows a builder to keep close track of the revenue, cost, and gross profit of pre-sold homes. Like the folks at Great Falls Construction, any builder using this accounting method will be able to gain a better understanding of the status of homes in progress. It is simply the best method for matching revenue to costs for custom builders who primarily build pre-sold homes.
The percentage-of-completion method provides three great advantages. First, it forces you to re-examine your estimate on a monthly basis. Second, it allows you to measure production because every month's costs and gross profits are being analyzed on the income statement—costs are not being buried on a balance sheet. Third, it helps you to project future revenue.
In past columns, I have discussed the concepts and mechanics of percentage-of-completion accounting. In this article, I will provide an analysis of Sample Custom Builders' earnings from construction and work-in-progress reports.
In Sample Custom Builders' income statement we saw that the company earned $1,100,000 in revenue and $198,000 in gross profit for the month. The earnings from construction report (see Sample Report 1) gives Sample Custom Builders a tool to dig deeper and see why the company did not hit its budget target by examining the types of jobs that lost margin. Using this report Sample Custom Builders notices margin slippage on custom homes in progress, with a gross profit of 16.25% for the month compared to 18.37% for the year to date. This report also shows that profit margins from remodeling jobs improved during the month. The year-to-date information indicates that margins from completed jobs (both the spec and custom homes) have brought down the company's overall margins and that remodeling projects provided only 15% of the company's revenue for the year but added 26% of the gross profit. This report raises a few questions:
- Should the company expand more into remodeling?
- Did margins fall on the spec home because the house was not the right product or had more features than the market was willing to pay for? If Sample continues to build spec homes, what will it do differently on the next home?
- With lower margins on completed homes and slippage during the month on custom homes in progress, what systems are in place to make sure that estimates to complete are accurate?
On which custom homes did margins slip? Sample Custom Builders prepares the following work-in-progress report (Sample Reports 2-4 below and on following pages) to dig deeper and to gain an understanding of why margins slipped during the month. The report also provides information that will enable the company to adjust its income statement to be reported in the percentage-of-completion accounting method.
In computing percentage of completion, only four items need to be pulled from job cost accounting records and entered into the work-in-progress report. They are:
- Current contract: original contract plus change orders executed through the end of the accounting period.
- Total estimated costs: current estimate of total anticipated costs on the job. This estimate should be updated to account for any projected budget over- or under-runs as well as include estimated costs on all change orders included within the current contract amount.
- Costs to date: total costs incurred on the job from inception through the end of the accounting period.
- Billed to date: total billings (draws) taken on the job from inception through the end of the accounting period.
